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US Federal Reserve Board Releases More Guidance On Key Banking Regulations – Finance and Banking

Table of Contents

On December 30, 2021, the Board of Governors of the Federal
Reserve System (“Board”) published additional answers to
frequently asked questions (“FAQs”) about its Regulations
H, O, W, and Y.1 Those regulations
govern Federal Reserve System membership, extensions of credit to
bank insiders, transactions with affiliates, and bank holding
companies and change in control, respectively. The FAQs also
addressed questions regarding the regulatory treatment of covered
savings associations (“CSAs”) and their parent
entities.

The FAQs are part of transparency initiative that was
spearheaded by former Federal Reserve Vice Chair Randy Quarles and
build on the significant body of guidance that was released in
March 2021. (Please see our earlier Legal Update on the Board’s
release of guidance in March.)

In this Legal Update, we summarize the FAQs with a particular
focus on the effect their release may have on the industry’s
understanding of the restrictions on affiliate transactions and
implications of using the CSA regime.

Overview

The FAQs address Regulations H (five new answers), O (one new
answer), W (34 new answers), and Y (nine new answers) and the CSA
regime (29 answers). Some of the FAQs address highly fact-specific
circumstances, such as the notice requirement for closing a
seasonal branch or the operation of the sister-bank exemption.
Other FAQs restate general principles of the regulation, such as
the application of the restrictions on affiliate transactions to
banks that are directly controlled by natural persons. However,
many of the FAQs clarify items that are not apparent from the plain
text of the regulation or had been understood only through agency
discussions.

Regulation H – Membership of State Banking
Institutions in the Federal Reserve System

The FAQs on Regulation H primarily address filing requirements
for branches of state member banks. One FAQ also addresses when a
state member bank is allowed to rely on the authority to make
public welfare investments to invest in housing projects consisting
of multiple buildings.

Potentially the most significant FAQ on Regulation H addresses a
state member bank’s authority to acquire debt obligations under
its lending authority. State member banks must comply with
limitations under the Federal Reserve Act when purchasing, selling,
underwriting, and holding investment securities. The FAQ states
that the Board will not apply these limitations if a state member
bank’s acquisition is an exercise of its lending authority
under state law and would be an exercise of lending authority for a
similarly situated national bank. In particular, the FAQ indicates
that Board staff will look to interpretations issued by the staff
of the Office of the Comptroller of the Currency (“OCC”)
to understand the lending authority of national banks. More
importantly, the FAQ states that Board staff will consider the
circumstance at the time the bank acquired the obligation and will
not permit banks to recharacterize past purchases of investment
securities as exercises of the bank’s general lending
powers.

Regulation O – Loans to Executive Officers, Directors
and Principal Shareholders

The FAQ on Regulation O clarifies circumstances in which a
member bank may offer discounts or preferential terms on loans to
insiders. Specifically, it states that a member bank may extend
credit to an insider as part of a benefit or compensation program
that (i) is widely available to employees of the member bank and
(ii) does not give preference to any insider of the member bank
over other employees of the member bank. However, a member bank is
prohibited from extending credit to an insider that is not made on
substantially the same terms as, or is made without following
credit underwriting procedures that are at least as stringent as,
comparable transactions with persons that are non-insiders and not
employees of the bank.

Regulation W – Transactions Between Banks and Their
Affiliates

The FAQs on Regulation W focus on the attribution rule,
sister-bank exemption, and valuation issues. As with the March 2021
guidance, some of the FAQs express positions of Board staff that
are more akin to a rule than supervisory guidance. Among the more
significant points of clarification are:

  1. The attribution rule should not apply to a series of
    transactions if the initial transaction involving the bank
    qualifies for an exemption.

  2. The Board should not apply the attribution rule if the bank did
    not know or have reason to know at the time of the transaction that
    the proceeds of the transaction may be used for the benefit of, or
    transferred to, an affiliate. This knowledge qualifier is
    conditioned on the bank maintaining a reasonable Regulation W
    compliance program.

  3. Extensions of credit to employees and insiders of affiliates
    typically should not be attributed to the affiliate.

  4. Floor-plan financing by a nonbank affiliate can create an
    attributed extension of credit when the bank extends credit to a
    third party to purchase a good from the floor-plan borrower.

  5. Regulation W applies to asset purchases at the time the bank
    commits or becomes legally obligated to purchase the asset from the
    affiliate.

  6. Loan renewals may terminate the attribution of a purchased
    loan, but refinancings and restructurings prior to maturity will
    not.

  7. Non-cash dividends, such as shares of an operating subsidiary,
    may create covered transaction issues.

  8. The meaning of “item” for purposes of the exemption
    for giving credit for uncollected items is generally limited to
    items as defined in Regulation J.

  9. Non-US dollar deposits may not be used as cash collateral.

  10. Cash collateral cannot be used to reduce the amount of a
    covered asset purchase transaction, but cash contributions from the
    affiliate should reduce the amount.

Regulation Y – Bank Holding Companies and Change in
Bank Control

The FAQs on Regulation Y focus on anti-tying, control, and
complementary authority issues. Notably, one of the FAQs seems to
confirm the longstanding belief that the industry generally may
rely on positions taken in the 2003 Anti-Tying Act proposal (e.g.,
what is a traditional banking product) even though it was never
finalized.2

The FAQs also state that a financial holding company with
physical commodity trading authority may not make or take physical
delivery of a specific physical commodity solely on the basis that
the commodity has swaps that are eligible to be traded on a swap
execution facility because the relevant approval orders only
address futures or options on futures that are authorized for
trading on a US futures exchange.

Regulation of CSAs

Section 206 of the 2018 Economic Growth, Regulatory Relief, and
Consumer Protection Act allows federal savings associations
(“FSAs”) to elect to operate as CSAs.3 A CSA has the same rights and
duties as a national bank that has its main office situated in the
same location as the home office of the CSA but retains its FSA
charter and is treated as an FSA for governance purposes. The OCC
is the primary federal regulator of CSAs and adopted rules
implementing Section 206 in 2019.4

The Board is the primary federal regulator of bank and savings
and loan holding companies and regulates aspects of the operations
of banks and savings associations. The Board has not adopted rules
that implement Section 206, but the FAQs state how the Board
construes the portions of the CSA regime that are within its
remit.

The key points from the FAQs on the CSA regime are:

  1. A savings and loan holding company (“SLHC”) that
    controls a CSA is treated as a bank holding company
    (“BHC”), except for the governance purposes enumerated in
    Section 206, and does not need to register with the Board as a BHC.
    The exception would be for an SLHC that is not a
    “company” for purposes of the Bank Holding Company Act
    and, therefore, would remain supervised as an SLHC only for the
    enumerated governance purposes.

  2. A CSA must become a member of the Federal Reserve System. This
    requires the CSA to purchase stock of the appropriate Federal
    Reserve Bank.

  3. A company that already controls a CSA must file a FR Y-10 with
    the Board to report the CSA’s election and comply with any
    other Board reporting requirements for BHCs. A CSA must submit Form
    FR 2030a to the appropriate Federal Reserve Bank for the required
    stock purchase under the Federal Reserve Act and comply with any
    other Board reporting requirements for national banks. A company
    acquiring control of a CSA or a company that controls a CSA must
    submit an application to the Board under Section 3 of the Bank
    Holding Company Act.

  4. A company that controls a CSA may engage only in activities
    that are permissible for a BHC. A grandfathered unitary SLHC
    permanently loses its grandfathered rights following a CSA
    election.

  5. A CSA must continue to provide notice to the Board prior to
    declaring a dividend.

Conclusion

The publication of these and prior FAQs by the Board staff
brings greater transparency to its historical guidance on the Board
regulations to stakeholders who lack back-channel sources of
communication with staff. However, because the use of supervisory
guidance to establish new legal requirements raises concerns
regarding the administrative rulemaking process, the Board staff
was careful to note that the FAQs are staff interpretations and
have not been approved by the Board, except as otherwise noted.
Thus, banking organizations should recognize that while the FAQs
are helpful in assessing their compliance requirements, they are
not legally binding on the Board.

With respect to the FAQs related to Regulations H, O, W, and Y,
the Board has indicated that it intends to propose amendments to
the underlying regulations. Given the obligations imposed on
institutions by several of those FAQs, such rulemakings may be
needed to avoid due process and Administrative Procedures Act
concerns. However, the Board is not doing the same for the FAQs for
CSA, which impose significant requirements on CSAs and companies
that control CSAs, including the divestiture of BHC-impermissible
activities. It is unclear why the Board did not previously
undertake, and apparently is not now contemplating undertaking, a
rulemaking to implement Section 206 of the Economic Growth,
Regulatory Relief, and Consumer Protection Act.

Lastly, it remains to be seen how much of the transparency
initiative will outlive Governor Quarles’ time on the Board.
While the expected rulemakings on Regulations H, K, O, W, and Y
hopefully are far enough along to be issued in the coming months,
the arrival later this year of a new vice chair for supervision and
potentially up to three new governors to the Board may cause the
Board to divert staff resources to other priorities and limit
future releases of FAQs.

Footnotes

1. See Legal Interpretations FAQs of the Board’s
Regulations
(Dec. 30, 2021), https://www.federalreserve.gov/supervisionreg/legalinterpretations/legal-interpretations-of-the-boards-regulations.htm

2. 68 Fed. Reg. 52,024 (Aug. 29, 2003).

3. Pub. L. 115-174 § 206, 132 Stat. 1296,
1310-11 (2018) (codified at 12 U.S.C. §
1464a).

4. 84 Fed. Reg. 23,991 (May 24, 2019) (codified
at
12 C.F.R. pt. 101).

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